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Pensions Tax Manual

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The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: performing the lifetime allowance test on a benefit crystallisation event (BCE)

Glossary PTM000001
   

Where benefit crystallisation events (BCEs) occur simultaneously 
Effective date of a benefit crystallisation event 
What is meant by ‘becoming entitled’ to various kinds of pension 
What is meant by ‘becoming entitled’ to a lump sum 
Phased retirement and fund designation 
Testing against the lifetime allowance at age 75 
Unused uncrystallised funds applied to dependants’ or nominees’ pension after a member’s death

Where benefit crystallisation events (BCEs) occur simultaneously

Sections 219(6),(7)and(7A) and 166(2)(a) Finance Act 2004

Normally benefit crystallisations events (BCEs) use up a member’s available lifetime allowance in the chronological order in which they occur. But it is possible that BCEs will occur simultaneously. The exception is where a pension commencement lump sum is paid. The BCE 6 will always be treated for lifetime allowance purposes as occurring immediately before the crystallisation of the associated BCE 1, 2 or 4, as appropriate. PTM088670 explains this in more detail.

Subject to the above, where more than one BCE occurs on the same date - whether under the same or different registered pension schemes, or different arrangements within a registered pension scheme - the member must decide the order the BCEs take for the purpose of the lifetime allowance test. This is important where the member’s lifetime allowance is breached at that point, as the order of the BCEs will determine which event creates the excess and is subject to the tax charge.

Whether or not simultaneous BCEs are likely to occur, and if so the order they should be considered in, is something the scheme administrator will want to ascertain from the individual when they contact the member before the BCE occurs - see PTM088400.

Where the member exceeds their lifetime allowance when crystallising benefits under a registered pension scheme, the payment of any lifetime allowance excess lump sum must always be treated for lifetime allowance purposes as having occurred after all other BCEs. This is because the member must have used up all their lifetime allowance before such a lump sum can be paid. The example below explains this.

The position is different where dealing with the payment of a relevant post-death BCE. If two or more BCE 5Cs, BCE 5Ds or BCE 7s (including a combination of any two or more of these three types of BCE) occur following the death of a member then, for the purposes of comparing the amounts crystallising at those BCEs with the member’s available lifetime allowance, those BCEs are deemed to have occurred at the same time - see PTM085000.

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Effective date of a benefit crystallisation event

Sections 165(3) and 166(2) Finance Act 2004

The Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171

For BCE 1 the date of the BCE is the date the funds are designated as being available to provide the member with drawdown pension.

For BCEs 2, 3, 4 and 6 the date of the BCE is the date the member acquires an actual (as opposed to a prospective) entitlement to payment of the relevant authorised pension benefit under the arrangement concerned. However, note that there is no BCE 6 where entitlement to a pension commencement lump sum arises on or after that date and before the member reaches age 75 but the lump sum is not paid until after the member has reached age 75. This is because the funds used to provide the pension commencement lump sum will in the meantime have been tested against the member’s lifetime allowance under BCE 5B, when they reached age 75 - see PTM088650.

  • With BCE 5 the effective date of the BCE is the member’s 75th birthday. Here the BCE is only testing the prospective entitlements the member holds under a defined benefits arrangement at that specific point in time.
  • With BCE 5A the effective date of the BCE is the member’s 75th birthday. Here the BCE is only testing the net growth since the original designation of funds being available for drawdown pension.
  • With BCE 5B the effective date of the BCE is the member’s 75th birthday. Here the BCE is only testing any remaining unused funds held in a money purchase arrangement.
  • For BCE 5C the effective date of the BCE is the date the deceased member’s funds are designated as being available to provide the dependant or nominee with drawdown pension. But where more than BCE 5C, BCE 5D or BCE 7 (or a combination of any 2 or more of these three types of BCE) occurs in respect of that member (from any registered pension scheme) they are treated as occurring simultaneously immediately before the member’s death, solely for the purpose of comparing the amount crystallising at those BCEs with the individual’s available lifetime allowance - see PTM087000
  • With BCE 7 the effective date of the BCE is the date the relevant lump sum death benefit is paid. But where more than one such payment - or BCE 5C or BCE 5D - is made in respect of that member (from any registered pension scheme) those BCEs are treated as occurring simultaneously immediately before the member’s death, solely for the purpose of comparing the amount crystallising at those BCEs with the individual’s available lifetime allowance - see PTM088680
  • For BCE 5D, the effective date of the BCE is the date the dependant or nominee acquires an actual entitlement to the annuity, similar to the timing of member’s lifetime annuity entitlement for BCE 4.  See BCE 5C comments above regarding simultaneous BCEs.
  • For BCE 8 the effective date of the BCE is the date the overseas transfer is made (see PTM088690 to see how to work out this date).
  • For BCE 9 the effective date of the BCE varies according to which regulation of The Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171 the payment is made under:

 

  • in the case of Regulations 16 and 19 (payment of arrears of pension and lump sums after death), the BCE 9 occurs immediately before the death of the member, and
  • in the case of Regulations 17 and 18 (lump sums based on pension errors), the BCE 9 occurs on the same date as the BCE 6 to which it is related.

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What is meant by ‘becoming entitled’ to various kinds of pension

Section 165(3) Finance Act 2004

A member with the expectation of receiving pension payments at some time in the future is said to have a ‘prospective right’ to pension. This pension may be in any of the forms described in PTM061300. For the purposes of the legislation, the member only becomes ‘entitled’ to a pension benefit at the point when they first obtain an ‘actual right’ to receive it. This ‘actual right’ has to be distinguished from their ‘prospective right’. An ‘actual right’ is when a member has the right to a benefit without having to fulfil any further conditions or take any further actions, for example:

  • having to agree to or authorise the payment of a benefit or
  • having to obtain an employer’s or scheme trustee/scheme administrator’s agreement or co-operation to benefit payment.

Although the term ‘actual right’ refers to the receipt of real benefit, rather than merely being in possession of a right to obtain it, it does not necessarily refer to the date a benefit is actually paid out.

Entitlement to drawdown pension specifically arises whenever all or part of the sums and assets within a money purchase arrangement are designated to be available to pay a drawdown pension. See example 5 below.

Determining the point at which entitlement to a scheme pension or lifetime annuity actually arises can call for a more careful application of the principles explained above. Examples 1 - 5 show how this works in more detail.

Example 1

Michael’s pension scheme rules state that pension benefits will come into payment on the member’s 65th birthday. This should happen automatically as Michael has notified the scheme of the option he wishes to exercise and has confirmed all the necessary information, for example bank details, to put the pension into payment. Michael is 65 on 15 September but his scheme experiences internal administrative delays and does not pay him any benefits until 1 October that year, but Michael still has an actual right to the payment of benefits on his 65th birthday, so his benefit entitlement arises on 15 September, not the actual benefit payment date of 1 October.

Example 2

The rules of Asif’s pension scheme state that a member may receive benefits from age 55 onwards and that benefits must come into payment by age 75. Asif is 57. Although Asif is eligible to take benefits from the scheme he has not yet opted to take benefits. So his right to benefits is prospective, not actual. He does not yet have any benefit entitlement.

Example 3

This is a variation on Example 1.

The rules of Yvette’s pension scheme state that pension benefits will come into payment on the member’s 60th birthday. According to scheme records, Yvette’s 60th birthday is on the 13 December 2013, so six months before that date, the scheme administrator writes to her last known address to ask what account she wants the benefits paid into. However there is no reply and the scheme is not able to contact Yvette to finalise the formalities. They are unable to make the payment on Yvette’s birthday in December. It is another year before they are able to trace her and details of the bank account to pay into are not confirmed to them until the 5 January 2015. Under the benefit rules of the scheme, Yvette’s benefits accrued to the 13 December 2013 and were due to be paid from that date, but by virtue of the matter-of-fact delay, Yvette’s entitlement remained a prospective one. Yvette has only become ‘actually entitled’ to the benefit for the purposes of the tax rules, on the 5 January 2015. Under the rules of the scheme, the scheme also must pay arrears of pension for the period between the ‘potential entitlement’ on 13 December 2013 and the date of ‘actual entitlement’ on 5 January 2015. This is permitted under SI 2006/614 for defined benefit schemes and so the arrears of her scheme pension will be taxable pension’ income.

Example 4

Kim has exercised her option to receive a lifetime annuity from an insurance company of her choice that does not underwrite the benefits in her pension scheme. There is an administrative delay within her scheme; payment of the consideration to the insurance company to purchase the annuity is delayed, and her lifetime annuity cannot start on time. Until the purchase price is passed to the insurance company, there can be no certainty that the annuity will be secured at a given rate, so the rights remain prospective, and actual entitlement is delayed until an insurance company does accept that payment of the consideration was made. Eventually an insurance company receives the payment for an immediate annuity and are then bound to pay out the annuity from whatever is the start date under the terms of the contract. The date on which payment was effectively made for the annuity becomes the date of ‘actual entitlement’. This is because although Kim completed all the steps that were required of her to obtain the benefit, it was not until payment of the consideration was made to the insurance company that one could define what the entitlement was to. The fact that the annuity is paid monthly in arrears does not affect the actual entitlement date. If the insurance company paying Kim’s annuity had an internal administrative delay resulting in the late payment of her annuity that would not have delayed her actual entitlement either. It is only the scheme delay that extended the final action that Kim performed in choosing the insurance company that would make the annuity payments.

Example 5

On 3 May 2014, Wale designates £10,000 from his pension fund as being available for the payment of a drawdown pension. He has made similar designations in the past. It is another two years before Wale actually starts to draw any pension from the designated funds. However for the purposes of the tax rules he is considered to have become actually entitled on 3 May 2014 to a drawdown pension from the £10,000 designated on that day.

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What is meant by ‘becoming entitled’ to a lump sum

Section 166(2) and 216 Finance Act 2004

Paragraphs 1 to 3A and 4A Schedule 29 and paragraph 15A Schedule 32 Finance Act 2004

The Taxation of Pension Schemes (Transitional Provisions)(Amendment)Order 2009 - SI 2009/1172

Regulations 17 and 18 of the Registered Pension Schemes (Authorised Payments) Regulations 2009 - SI 2009/1171

Pension commencement lump sum

BCE 6 occurs when the entitlement to the pension commencement lump sum arises. The lifetime allowance test is carried out using the lifetime allowance at that point of entitlement, so it is important to understand when that point arises.

For a pension commencement lump sum, the entitlement is normally deemed to arise immediately before the entitlement to the linked scheme pension/drawdown pension/lifetime annuity (see PTM062310), so that the two BCEs will always be linked. This date may well be different from the date that the lump sum was actually paid, as the lump sum can be paid up to 6 months before or 12 months after the entitlement to it arises.

However, where a pension commencement lump sum is paid in relation to a money purchase arrangement and the individual becomes entitled to it after 5 April 2011 and before reaching age 75 but it is not paid to the individual until after they have reached age 75 there is no BCE 6. This is because the funds used to provide the pension commencement lump sum will already have been tested against the member’s lifetime allowance when they reached age 75 under BCE 5B (see PTM088650).

Where the lump sum is a scheme-specific protected pension commencement lump sum that is linked to a small pension right, and that pension right is in turn paid out as a trivial lump sum (as described at PTM063130), the entitlement to the scheme-specific protected pension commencement lump sum is deemed to arise immediately before the entitlement to the linked trivial lump sum arises.

There are however special rules about the date of entitlement, which apply where a lump sum has been paid in anticipation of entitlement to any of the above kinds of pension arising within the following 6 months, but the member dies before that entitlement actually arises. In such circumstances, the payment may nonetheless be treated as a pension commencement lump sum and entitlement to the lump sum is deemed to have arisen immediately before the member’s death. The lifetime allowance test would then be carried out using the lifetime allowance at that time. The entitlement to the amount of lump sum arising immediately before the member’s death is regarded as using up lifetime allowance before the deemed occurrence of BCE 5Cs, BCE 5Ds or BCE 7s arising from the payment of relevant post-death BCEs - see PTM088500.

Overpaid pension commencement lump sums

Where the amount of a pension commencement lump sum is overpaid in ‘good faith’, within the narrow circumstances outlined in PTM063250, the amount that has been overpaid will typically sit alongside the correct portion of the total lump sum provided. That correct portion is a normal pension commencement lump sum and entitlement to it arises in the normal way, as explained above. It is subject to BCE 6 - again in the normal way, as explained above.

However, the overpaid portion of the lump sum (the amount above the permitted maximum) is not strictly a pension commencement lump sum: rather it is a lump sum paid in error. Assuming it meets the narrow circumstances of the above regulations, the amount of the lump sum paid in error establishes an amount crystallised under BCE 9. Normally one must determine the time at which entitlement to any lump sum arises, in order to determine when to value the crystallising payment. In this case however, even though BCE 9 is calculated according to the amount of the overpayment, and strictly under the tax rules that overpayment is a separate lump sum, the regulations anchor its crystallisation to the member becoming entitled to ‘the other lump sum’, namely to the correct portion - the underlying pension commencement lump sum (which is itself valued for the BCE 6 mentioned above). This merging of the two lump sums for timing purposes makes sense if you consider the scheme only ever intended to pay one lump sum all along.

So the correct portion of pension commencement lump sum provides the point of entitlement which is used to determine when both portions of the lump sum crystallise under their respective BCEs (6 and 9). In this way, the two BCEs (6 and 9) are said to arise simultaneously, but have different values according to the two different elements of the lump sum provided.

Example

A scheme administrator calculated that Annaliese had an entitlement to a commuted pension commencement lump sum of £80,318, leaving a residual scheme pension of £12,047. Annaliese received these benefits, but the scheme administrator later realised that, owing to an incorrect commutation factor being applied, the correct pension commencement lump sum should have been £80,000 and the correct scheme pension £12,000. These lower figures represent the member’s true entitlement under the scheme, but the administrator does not want to inconvenience the member too much, and allows the overpayments that have been made so far to stand. They do however adjust the level of pension for the future, reducing it to the member’s correct and true entitlement - see PTM062800.

The legitimate part of the lump sum, £80,000, is the true pension commencement lump sum subject to BCE 6. As the matter is covered in the regulations, the remaining part, £318, is tested against the lifetime allowance under BCE 9.

Uncrystallised funds pension lump sum

The member becomes entitled to the uncrystallised funds pension lump sum immediately before it is paid. The BCE 6 therefore occurs at that time.

‘Pension commencement’ lump sums finalised after death of the member

Where a BCE arises in the circumstances covered in PTM088100 (commencement lump sums paid after death), the amount paid is said to crystallise under BCE 9 at the date of death.

Other types of lump sum

With any other type of authorised lump sum (apart from death benefits, see PTM088680), the lifetime allowance test is made on the date the member acquires an actual entitlement to the lump sum. For the purposes of the legislation, the member only becomes ‘entitled’ to a lump sum at the point when they first obtain an ‘actual right’ to receive it. This ‘actual right’ has to be distinguished from their ‘prospective right’. An ‘actual right’ is when a member has the right to a lump sum without having to fulfil any further conditions or take any further actions, for example:

  • having to agree to or authorise the payment of a lump sum, or
  • having to obtain an employer’s or scheme trustee/scheme administrator’s agreement or co-operation to a lump sum payment.

The lifetime allowance test is carried out using the lifetime allowance at the date of entitlement, which may be different from the date of payment.

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Phased retirement and fund designation

Sections 165(3) and 216(1) Finance Act 2004

Schedule 28 Finance Act 2004

Where a member draws their entitlements under an arrangement in stages, whether through fund designation in a money purchase arrangement or through staggering a scheme pension or other benefit entitlement, each fresh entitlement is a separate BCE.

Example

Trevor has a fund valued at £200,000 held under a money purchase arrangement. On his 58th birthday he decides to draw benefits from half his fund (£100,000). He draws £25,000 as a pension commencement lump sum, and chooses to use (designates) the remaining £75,000 for drawdown pension.

A lifetime allowance test is triggered on the date of his birthday through the payment of the lump sum (BCE 6) and the designation of funds to provide a drawdown pension (BCE 1). The amount crystallising at these two BCEs are £25,000 through BCE 6 and £75,000 through BCE 1 - £100,000 in total.

The BCE 6 is deemed to occur first, although this has no significance in Trevor’s situation because neither BCE leads to him exceeding his available lifetime allowance.

Five years later, aged 63, Trevor decides to take benefits from the remaining uncrystallised funds held in the arrangement. These funds are now worth £110,000. Trevor again draws the maximum pension commencement lump sum of £27,500 and uses the remaining £82,500 to generate a drawdown pension (adding to the funds already designated).

A second lifetime allowance test is triggered at that point as there have been two new BCEs. The amounts crystallising at the two BCEs are BCE 6: £27,500 and BCE 1: £82,500 - £110,000 in total.

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Testing against the lifetime allowance at age 75

If any benefits in a registered pension scheme have not been drawn or designated for drawdown pension by the member’s 75th birthday, they are valued and tested for lifetime allowance purposes at that point.

The only BCE that can occur after an individual’s 75th birthday is where a scheme pension in payment is increased beyond the permitted margin, through BCE 3.

PTM088650 explains the BCEs at age 75.

If the member wishes to take a pension commencement lump sum after reaching age 75 then, solely for the purposes of deciding whether the member satisfies the pension commencement lump sum condition that they have available lifetime allowance (see PTM063200), the fact that a BCE 5 or 5B has occurred is disregarded. So any LTA used up by a BCE 5 or 5B does not count in calculating whether the member has available lifetime allowance.

On the other hand, if the member has already taken benefits from the same or another arrangement under a registered pension scheme after age 75 or some other event has occurred that would have been a BCE but for the fact that the event occurred on or after the member reaching age 75, then solely for the purposes of calculating whether the member has available lifetime allowance as a condition for paying a pension commencement lump sum, those events are treated as though they were BCEs. See PTM063200 for more details.

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Unused uncrystallised funds applied to dependants’ or nominees’ pension after a member’s death

Where a member dies without having crystallised all their money purchase pension savings, a BCE 5C or BCE 5D occurs in the following circumstances:

  • the member has died before their 75th birthday
  • their ‘relevant unused uncrystallised funds’ are designated for the payment dependants’ or nominees’ flexi-access drawdown pension, or (for deaths on or after 3 December 2014) are used to provide entitlement to a purchased dependants’ or nominees’ annuity
  • the designation or entitlement occurs on or after 6 April 2015
  • the designation or entitlement occurs within the period of 2 years beginning with the date the scheme administrator first knew of the member’s death, or the date they could first reasonably have been expected to have known of it (if earlier).

Because the flexi-access drawdown pension payments or annuity payments to the dependant or nominee are free of income tax, a lifetime allowance test is carried out on the amount now applied for the dependant or nominee’s pension or annuity. See PTM088660 for more detail.